Poor Returns Cast Cloud Over BRIC Equity Funds

Investors fed up with years of poor returns are deserting BRIC equity funds, pushing share valuations to record cheap levels and questioning the future of the high-profile investment theme.

LONDON - Investors fed up with years of
poor returns are deserting BRIC equity funds, pushing share
valuations to record cheap levels and questioning the future of
the high-profile investment theme.

The term, coined in 2001 by Goldman Sachs banker Jim
O'Neill, provided a catchy acronym to unite the four biggest
emerging economies, two of which were also growing at
turbo-charged 9-12 percent rates.

Since then economic growth in Brazil, Russia, India and
China has surpassed even O'Neill's expectations, their aggregate
GDP having quadrupled to create the equivalent of five British
economies. It looks likely, as O'Neill reckons, the BRICs will
account for almost a third of the world economy by 2020, up from
20 percent now.

Applying the concept to equity investments has proved less
rewarding, however.

Viewed over 10 years, MSCI's BRIC index has returned a
handsome 450 percent, Thomson Reuters data shows, versus 320
percent on emerging markets and 98 percent on developed markets.

But much of that is due to an explosive start. MSCI's BRIC
index returned over 500 percent from 2001 to 2007, significantly
outperforming emerging markets. Returns have since slumped, with
losses of 8.6 percent in the past five years in dollar terms.
The main EM index has returned 5 percent in this period.

That has taken a toll on the BRIC funds that proliferated
after 2001 to capture these countries' booming economic growth.

The funds' asset base has almost halved from the 2007 peak
to around 12 billion euros, according to data from Lipper, a
Thomson Reuters company. And investor interest has reversed --
fund tracker EPFR Global reports outflows of $1.1 billion from
BRIC funds in 2012, extending last year's $5.4 billion loss.

Broader emerging funds though are still drawing plenty of
interest, absorbing $18 billion this year. And Lipper data shows
their asset base has doubled since 2006 to 214 billion euros.

All that is providing fodder to critics who view BRIC funds
as an arbitrary grouping of four vastly differing markets.

"We don't think of BRICs as an entity. Our strategy is to
see which companies we like and we own those companies," said
Jeff Chowdhry, a fund manager at F&C Investments.

"BRIC is an investment fad that's had its day. What you will
see is more and more of these funds quietly closing down."

This year, MSCI BRIC has gained less than 1
percent while emerging markets are up 6 percent.

WHAT WENT WRONG

It is worth remembering that while growth, underpinned by
demographics and consumption, was BRIC funds' main sales pitch,
it was never a guarantee of equity profits.

As an oft-cited study from Credit Suisse/London Business
School notes, the link between growth and stock-market
performance is "statistically weak and often perverse".

"There were a lot of opportunistic fund launches based on
the false premise that you could separate the BRIC markets from
others because of their supposed GDP potential and size," said
John-Paul Smith, head of emerging equities at Deutsche Bank.

China makes up 40 percent of the MSCI BRIC index. But during
two decades of double-digit gross domestic product growth,
equity investors have swallowed a 10 percent loss.

The BRICs' liquid markets and big, well-known companies may
also have been their undoing. In 2002 the BRICs offered a
significant measure of diversification for investors keen to
venture into emerging markets but wary of smaller markets.

That diversification advantage has almost vanished, with the
BRIC index moving in lock-step to developed markets: correlation
is now at 0.9 compared with just 0.4 a decade ago.

And these big companies, from Russia's Gazprom to Brazil's
Petrobras, are often state-run or subject to state meddling. And
that has taken a heavy toll on their shares.

PRICED FOR WORST CASE

So does BRIC have a future as a strategy?

The concept still has plenty of fans. Bill Maldonado, head
of equities at HSBC Global Asset Management, says BRIC offers a
liquid and convenient proxy for EM. He likens it to FTSE-100, an
index of the top companies from London's FTSE All-Share index.

Like other BRIC bulls, he reckons current record cheap share
valuations - prices relative to expected future earnings - will
be the catalyst for BRICs recovery. Many see them priced for a
growth and profits collapse, rather than just slowdown.

The BRIC index is trading at 8.2 times forward earnings or a
15 percent discount to broader emerging markets, themselves
trading at a large discount to developed peers. In Brazil and
Russia, shares are 30-50 percent below their historical average.

"Investors have had macro concerns about those economies,
not concerns about individual companies," Maldonado says.

"If we have a stock or a market that's both cheaper and more
profitable than the universe, that's where we want to invest."

Goldman Sachs too advises clients to overweight BRIC shares,
using a BRIC fund in a diversified portfolio. They predict the
Big Four, especially China, are moving towards better-quality,
stable growth and that will eventually yield equity returns.

However, Kathryn Koch, senior portfolio strategist at
Goldman Sachs Asset Management, also recommends combining a BRIC
fund with a fund for Next-11 countries. That's Goldman-speak for
a second-tier group of fast-growth economies such as Mexico or
Turkey.